Allocate capital to emerging markets post-Brexit

Neal Smith of Denker Capital

Neal Smith, Portfolio Manager: Sanlam Investment Management Global Emerging Markets Fund.

“A fragile Europe and messy UK leadership race on top of an already low-growth world makes for an extremely tough macro backdrop for investors,” says Denker Capital’s Neal Smith, Portfolio Manager of the SIM Global Emerging Markets Fund, which has outperformed the MSCI Emerging Market Index by 12.2% over the last year to the end of June 2016. He believes that it may be time for investors to reconsider emerging markets, where consistent outflows over the past four years have increased their attractiveness.

He explains, “Generally speaking, most emerging market economies are in a much healthier state than the developed world, and their long-term growth outlook looks promising.”

In contrast, as a result of Brexit, uncertainty is high. This is according to Kokkie Kooyman, Portfolio Manager: Sanlam Global Financial Fund.

“The likelihood of a European Union (EU) break-up has increased considerably since the United Kingdom’s ‘leave’ vote. Similar referendums in other EU countries such as Italy, the Netherlands and France could have the same outcome. The UK has to re-negotiate the best possible trade agreements for itself, while the EU plays hardball as it attempts to discourage further referendums by other EU member states. Negotiations will be long and drawn out.”

He adds that with its leadership and the country divided, Britain will undergo a period of strife and a battle for leadership. “In most developed markets, the frustration of blue-collar workers with politicians and the increased competition from immigration will ensure continued political volatility. Thus, the probability of a weaker pound and a recession lie ahead.”

“The initial large sell-off was brought about by fund managers reducing their equity exposure, specifically UK (where they were overweight), Europe and also United States bank positions,” says Kooyman. “But as investors get more worried about the outlook for developed markets the sell-off is continuing.”

Speaking of the US, Kooyman believes that it is unlikely that the electorate will learn from the Brexit vote with Donald Trump already fighting his election on a trade protection basis, stating “We’ll protect your jobs against the Chinese”. He has threatened to withdraw from the North American Free Trade Agreement and has vowed to label China a currency manipulator and impose punitive tariffs on Chinese goods.

Kokkie Kooyman low res“Brexit could trigger a move away from globalisation, restricting free trade, pushing up costs, restricting the optimal allocation of capital and driving down returns on capital,” warns Kooyman.

With all of this uncertainty, Smith recommends that investors invest a percentage of their portfolio into emerging markets over the long term as this has had the dual benefit of increasing returns as well as decreasing risk.

“Although emerging markets generally remain somewhat more volatile than developed markets, the diversification of risk makes up for that. Year-to-date, emerging markets as a category have outperformed developed markets and the extent of this outperformance is set to increase further with time.

“Structural drivers of this outperformance include the fact that 82% of the world’s population lives in this region, it has 75% of all land and 63% of all natural resources.  In addition, there are powerful trends at play in emerging markets such as urbanisation that will continue to support their growth. Investors seem to be re-assessing the risk associated with investing in emerging markets due to the extent of emerging market outperformance. Contrary to common wisdom, the case can be made that emerging markets are now more predictable than the developed countries.”

He adds: “Emerging market valuations are looking particularly attractive and they are under-owned. Their currencies have been under pressure the last five years, reflecting global investor pessimism towards this asset class.

“Debt levels in many emerging market countries are low compared to their developed market peers. On top of this, many countries such as India and Indonesia have their own internal growth dynamics and positive reform agendas.

“We are convinced now is the right time to start allocating capital to emerging markets and launched our global emerging market fund 13 months ago.  We are finding many exceptional businesses to invest in that are trading materially below our assessment of what we believe they are worth.”

Smith adds that emerging markets are cheap, unloved and very under-owned by global investors.

“Emerging markets have possibly started their next cycle of outperformance.”

Denker Capital is an independent asset manager specialising in both local and offshore equities. The business was created in 2015 through the merger of SIM Unconstrained Capital Partners and SIM Global, two boutique businesses within Sanlam Investments.



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